With new, innovative financial instruments offering a greater array of investment vehicles and pathways into real estate, you have greater opportunities to diversify your portfolio. However, it is important to understand the different forms of investment to decide which of them best suit your needs and preferences.
Home ownership or property investment?
Buying a home for yourself requires very different considerations from investing in real estate. Location, personal situation, and personal preference are likely to be important criteria when you look for a home. By contrast, when investing in real estate as an asset, you might look at factors such as diversification, liquidity, and risk-return parameters.
Direct vs. indirect real estate investing – what is the difference?
Direct real estate refers to the direct purchase of physical real estate (multi-family houses, office buildings, hotels, etc.) with the aim of generating income and capital appreciation. Indirect real estate, on the other hand, involves investing in property through instruments such as REITs (real estate investment trusts, which are companies that own properties that produce income), listed or private real estate funds, rather than owning the bricks-and-mortar itself.
Real estate investment strategies
Within real estate, there are four types of investment strategies, with specific risk-return profiles ranging from rather conservative to relatively ambitious. The strategies are delineated by the type and quality of the tenants, the physical condition and the location of the assets, the type of value creation, and the quantity of debt used to acquire the asset.
Core
Core is the most well-known real estate investment strategy that most direct investors apply, notably listed funds and REITs. Some private real estate funds also apply this strategy. Investors buy good quality units to generate a stable income, almost like a bond. Properties require little maintenance and asset management and are often in prime locations, with high quality tenants with long-term leases. Investors acquire such assets using varying amounts of debt, typically ranging from 40 to 50 per cent, and generate annualised returns primarily or exclusively from the rental income they receive.
Core-plus
Another direct investment strategy is the ‘core-plus’ approach, which can be found in listed, REIT, and private real estate sectors. High-quality units often require a refresh or upgrade, or a complete management overhaul. This type of strategy requires a more hands-on owner or some form of delegation. The tenant base and leases are usually of good quality but might be improved. Therefore, there is a higher share of capital gains (10 to 20 per cent) in the overall expected returns.
Value-add
Typically, ‘value-add’ strategies require active involvement from knowledgeable owners and a dependable team. This is usually the realm of private real estate investing. The units suffer from management problems and may require significant repositioning, upgrades, and improvements. The tenant base may need a significant shift, the units may have occupancy issues, and the leases may need an overhaul. Annualised returns are expected to be between 11 and 15 per cent and come essentially (or at times exclusively) from capital gains (50 to 70 per cent).
Opportunistic
‘Opportunistic’ strategies are for expert owners usually committed full-time with a team or imply a delegation, and they are by essence a private real estate investing strategy. Units are subject to a turnaround, are redone from the ground up, and their destination can change. Major structural changes are on the programme, as well as redevelopment. Projects can take up to two or three years to be realised.
Annualised returns exclusively through capital gains can reach 15 to 20 per cent, with the proportion of debt usually between 60 and 80 per cent. Investing is usually for the mid- to long term, as units are resold once redone. Construction and development strategies are close to opportunistic strategies, except that the risks involve planning, permissions, and construction on virgin land. The use of debt is more limited (usually 40 to 50 per cent). Real estate debt is also an option for those willing to gain exposure to the sector, while significantly limiting risk and remaining hands-off.
Assessing your situation
Each investment avenue has its own specific risk-return parameters. Assessing your own risk appetite against the risk profiles of different investment options will allow you to determine the best investment strategy for you.
What type of investor are you?
Investing directly in real estate is exciting for hands-on investors. Buying and selling real estate requires significant capital, expertise, and know-how, plus the time, effort, and right resources (such as qualified contacts). Whether building new or buying existing units (such as housing units or commercial or office properties), direct investing often requires the use of debt (such as a mortgage) and the financial and technical knowledge to negotiate and structure such loans.
Investors comfortable in engaging in the construction of new properties and redevelopments may sell them on the market in an attempt to generate returns. Direct investors exercise some control over the projects. They identify opportunities – whether undervalued, underdeveloped, or high-potential properties – and execute a specific plan that leverages their know-how and expertise. Investing directly typically requires active involvement and a sound understanding of the local market, its dynamics, and specificities. As the saying goes, real estate is about ‘location, location, location,’ and a good direct investor needs granular and up-to-date knowledge.
Indirect investments are typically more attractive to hands-off investors, as they have lower barriers to entry compared to direct investing. Investing indirectly opens opportunities to build a diversified portfolio geographically, sector-wise, and in terms of value creation. No investor can claim to invest directly globally in every type of real estate asset and to execute any type of improvement or overhauling.
Passive investors can indirectly participate in all these dimensions, especially with the support of wealth management professionals to help them choose fund managers. Depending on the investment vehicle, it can also mean lower exit barriers, allowing investors to liquidate their position quicker and redirect funds into other investment opportunities.
To begin your real estate investing journey, it’s important to assess your own capabilities, goals, and expectations. In order to get started, we have provided an investor checklist in our Wealth Matters guide, available now.